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Credit derivatives get cracking

Want to lend to Fiat but your country limit for Italy is full? Want to take exposure to Brazil without also incurring US interest-rate risk? Want six-month exposure to the Philippines but there are no securities under two years in the market? The bold, new world of credit derivatives allows you to do all this and lots more. Mark Parsley reports.

Three years ago investment bankers began to talk about a new class of structured products - credit derivatives. But, despite the talk, almost the only deals done were for the investment banks themselves. Clients weren't interested and hedging was next to impossible.

But, at last, the talking is over and a significant number of transactions are getting done.

The potential of credit derivatives is immense. There are hundreds of possible applications: for commercial banks which want to change the risk profile of their loan books; for investment banks managing huge bond and derivatives portfolios; for manufacturing companies over-exposed to a single customer; for equity investors in project finance deals with unacceptable sovereign risk; for institutional investors that have unusual risk appetites (or just want to speculate); even for employees worried about the safety of their deferred remuneration. The potential uses are so widespread that some market participants argue that credit derivatives could eventually outstrip all other derivative products in size and importance.

The first deals were done in 1993 when Bankers Trust and Credit Suisse Financial Products (csfp) in Japan began selling notes whose redemption value depended on specified default events. "When the business started, it was about credit protection for the bank," says Philip Borg, a managing director at Bankers Trust.

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